In February 2020, India’s Finance Minister Nirmala Sitharaman pushed forward a novel idea to set up the first of its kind Social Stock Exchange (SSE) in India
This announcement was a welcome change and garnered a lot of positive interest and feedback from the international and domestic social community. Broadly, an SSE is a platform that allows investors to buy shares in a social enterprise that has been vetted by an official exchange. While this SSE will function on the lines of other major Indian stock exchanges like BSE and NSE, its main objective will be different – raise funds for social welfare as opposed to capital gains.
Under the regulatory ambit of Securities and Exchange Board of India (SEBI), India’s central securities commission, the SSE’s electronic fund-raising platform will essentially list both for-profit enterprises (FPE’s) and nonprofit organisations (NPO’s), allowing them to raise capital as equity, debt or as units like a mutual fund.
Currently, funding instruments for the social and developmental sector are mostly generated from philanthropic donations, government and private grants as well as foreign and CSR funding. Recent estimates & reports suggest that India needs a minimum of U.S. $350-$400 billion in annual funding to fulfil just five of the most important UN Sustainable Development Goals (SDG’s) by 2030 (zero hunger, good health, and well-being, quality education, gender equality, and clean water and sanitation)1. Even under optimistic scenarios, a funding gap of U.S. $60 billion may exist every year2. An SSE may allow funding channels to come together on a common platform and reduce this gap, and introduce a uniform framework for reporting and measuring social impact which will become an important step forward for the development sector in this country.
While the genesis of an SSE came prior to COVID-19, its need has become even more relevant in today’s uncertain times. The pandemic has caused grave economic damage with the maximum impact towards India’s vulnerable population which includes almost 300 million people living below the poverty line. A significant amount of capital will be needed in order to rebuild the lives of those who have lost not just livelihoods, but also homes and families to this pandemic. Government expenditure will not be sufficient, and thus private and social enterprises will need to step up their activities. The SSE will unlock large pools of capital and encourage blended financial structures to address these urgent challenges.
SEBI’s Working Group
In September 2019, SEBI constituted a working group on ‘Social Stock Exchanges’ (SSE) to recommend possible mechanisms to raise funds within the securities market domain and establish standards of social impact and financial reporting using institutions such as Information Repositories (IR) and social auditors. The group has recently released a report that gives form and content to the Finance Minister’s vision.
Key Recommendations by the Working Group
SEBI’s report defines objectives for the SSE and introduces the process to measure and report social impact. It outlines a number of recommendations for NPOs and FPEs and charts out funding structures for each, based on key principles for the Exchange. Finally, it discusses the need and applicability of the SSE during the COVID-19 crisis and makes certain policy recommendations.
One of the recommendations includes implementing a common minimum standard for reporting on social impact. This will help create uniformity in reporting which actively supports decision making for donors. In order to benefit from the SSE, the report recommends that NPOs must commit to reporting in accordance with the standards created. The NPO may also register with an IR in order to further prove its credibility and legitimacy to investors/donors.
How can NPO’s benefit from the SSE?
In order for NPOs to benefit from the SSE, SEBI’s report has come out with a number of recommendations.
- Zero Coupons Zero Principal: Funds from donors and investors can be unlocked in the form of Zero coupons zero principal bonds, which will be listed on the SSE. The tenure will be equal to the duration of the project that is being funded, and at tenure, they will be written off the investee’s books. In order to minimise risk to the investor, NPO’s can get legitimised by registering with IR’s.
- Social Venture Funds and Mutual Funds: Another recommendation is to activate and mainstream pre-existing funding structures such as Social Venture Funds (SVF) and Mutual Funds.
Currently, no SVF is being used for nonprofit activity as its charitable purposes have not been fully understood. For Mutual Funds, the returns generated would be channeled towards the functioning of NPOs and considered as donations; which can be managed by existing asset management companies.
- Funding Mechanisms: Various models can be followed to enable new funding mechanisms. Social impact bonds such as SIBs/DIBs can be brought under the SVF which will allow private investors to finance social services provided by NPOs. The investors are repaid if the providers achieve expected social outcomes. With social/development bonds, lending partners bear some risk if the promised social impact is not created. Risk can be minimised by choosing the NPO carefully.
- Fiscal Benefits: Lastly, there are a number of fiscal benefits for both the NPOs, as well as the donors/investors. The points which have been listed out in the SEBI report are for the Government to consider so that investors are further incentivised to invest their money, and NPOs register with the SSE along-with compliance with defined reporting standards.
- Foreign Contribution (Regulation) Act, 2010 (FCRA): Another way to unlock funds would be to enable foreign entities to invest in SVFs listed on the SSE, as the donors won’t have any discretion on the deployment of these funds to specific NPOs. These decisions will be taken by SEBI regulated Indian fund managers and will, therefore, be easier for the government to monitor as they will have to conform to the Information Memorandum to be made public. This may need clarifications/amendments under Foreign Contributions regulations.
How can FPE’s benefit from SSE?
FPE’s will use the SSE to raise equity capital; and the equity instruments will be tradable. Listing criteria will apply for FPEs, just as they apply for conventional enterprises who list on the main board of other stock exchanges such as BSE or NSE. However, the main difference will be that the FPEs will need to demonstrate that their business is actively creating a positive social impact. This will enable them to access a kind of capital that conventional for-profit enterprises do not have access to.
FPEs will also be able to raise funds using funding structures such as SVFs. SEBI recommends tax incentives to investors and tax relief to FPEs for a period of 5 years, to kick start activity on the SSE for FPEs. Association of these SSE will not be based on self-reporting, but a mechanism will be put in place to assess credentials of the social impact created.
Has this been done before?
Such structures exist in a number of countries including Brazil, South Africa, Singapore and Canada. Existing SSEs have worked as trading platforms that allow social businesses to raise capital by attracting ethical investors to invest in businesses that have a dual corporate and social mission. For example, Brazil’s Stock Exchange (BOVESPA), is closely linked to their SSE and uses the same expertise, rules, and tools of the daily stock exchange; this close connection guarantees transparency, credibility, and accountability.
Tax & policy changes
The report recommends that key areas of tax exemptions and policy should be amended by the Government to allow for SSE’s to be availed by enterprises. Some of these include:
- Allow philanthropic donors to claim tax exemption for their donations under 80G to NPO’s that benefit from the SSE, and remove the 10% cap on income eligible for deduction under 80G.
- Allow investments in NPO’s listed on SSE to be tax-deductible.
- Allow the first time retail investors to avail tax exemptions on investments in mutual funds under the SSE.
- Allow corporations to deduct CSR expenditure that goes to the SSE from their taxable income.
- Allow a tax holiday of five years to social businesses listed on the SSE, from the time of first listing.
- Fast-track the process of getting tax exemption approvals for NPO’s operating under the SSE
- Increase the limits under the Income Tax Act on charitable institutions raising funds from commercial or semi-commercial activities to 50 percent from the current 20 percent.
- Re-evaluate the current budget proposal to make the renewal of registration under 80G periodic.
In order to unlock more funds, the report recommends the Government make a few policy changes in relation to Corporate Social Responsibility (CSR as well):
- Allow funding to NPOs on SSE to count towards CSR commitments of companies.
- The Ministry of Corporate Affairs (MCA) may authorise the trading of CSR spends between companies with excess CSR-spends and those with deficit CSR-spends, and the SSE can provide a platform for this purpose.
For India, SSE’s are definitely the need of the hour, not just from a COVID-19 perspective but also for long term sustainable development in India. The pool of funds that get unlocked will greatly increase the number of resources available to benefit India’s burgeoning social needs including education, poverty, hunger, malnutrition, and environmental needs like pollution.
For international universities, nonprofits, as well as commercial enterprises who operate in the social sector, SSE’s will be a welcome change. International institutions and organisations can greatly benefit from additional resources created by the SSE and allow them to lend expertise and implement crucial projects in their areas of expertise. Such innovations will greatly foster areas of domestic research, which international organisations can greatly benefit and contribute to. A key historical concern for international organisations in India is the lack of transparency, reporting, and disorganised fundraising mechanisms – which may all be addressed well by the institutionalisation of a social sector exchange with appropriate rules and benchmarks for compliance.
Foreign institutions must embark on a careful and detailed assessment of benefits for their respective domains via this exchange and also align their local structures and activities accordingly to ensure that they can access SSE fundraising but also meet all the necessary compliance and reporting requirements. This can be achieved through both organic and inorganic means. Where this assessment yields positive results – investments must be aligned to increasing strength and capabilities in India in order to gain an advantage, meet demand, and ensure projects, objectives and implementation strategies align with the SSE and meet the social welfare objectives for the people of this country.