Prospects and Challenges of Social Stock Exchanges

WHY IN NEWS:

• A technical group on Social Stock Exchanges (SSEs), constituted by the Securities and Exchange Board of India (SEBI) has submitted its report.

WHAT IS SOCIAL STOCK EXCHANGE?

• Social Stock Exchanges (SSE) are dedicated platforms that allow investors to purchase stakes in social enterprises, volunteer groups and welfare organizations.

HOW IT WORKS?

• The SSE will function as a common platform where social enterprises can raise funds from the public.
• They come under the regulatory ambit of SEBI.
• Contrary to most capital market exchanges that allow firms to be listed when they meet certain business criteria, 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’
• Arguably, social stock exchanges have the potential to offer innovative solutions that utilize equity investments to create social impacts.
• The SSE can be housed within the existing stock exchange such as the Bombay Stock Exchange (BSE) and/or National Stock Exchange (NSE).
• However, the purpose of the Social Stock Exchange will be different - not profit, but social welfare.

EVOLUTION

• Union finance minister first floated the idea of social stock exchange for India in union budget speech for 2019-2020.
• Following the budget announcement, SEBI has set up a working group in September 2019 to examine and make recommendations on the structures and mechanics of a social stock exchange.
• The group has submitted its report in April 2021

THE NEED FOR SOCIAL STOCK EXCHANGES

• To meet the investment demand in human development sector:
  • India needs massive investments in the coming years to be able to meet the human development goals identified by global bodies like the UN.
  • This can’t be done through government expenditure alone.
  • Private enterprises working in the social sector also need to step up their activities.
• To solve the fund crunch faced by social enterprises
  • Social enterprises are very active in India. However, they face challenges in raising funds.
  • One of the biggest hurdles they face is, apparently, the lack of trust from common investors
  • As per a survey conducted by Brookings India, 57 per cent of the social enterprises identify access to debt and equity as a barrier to growth and sustainability.
• Transparency and accountability:
  • Because of rigorous due-diligence and performance metrics that an SSE would be installing for background checks for investors.
• Synergy between investor and investee in social aims:
  • Canvas of choice would be much wider allowing investor and investees with similar visions and missions to connect seamlessly.
• Performance- based philanthropy:
  • As performance of the enterprises listed on an SSE would be closely monitored, it will result into better project implementation.

SOCIAL ENTERPRISES IN INDIA – AN OVERVIEW

• A social enterprise is a revenue-generating business.
• Its primary objective is to achieve a social objective, for example, providing healthcare or clean energy.
• The enterprises that create social impact can be broadly categorized into two:
  • For-Profit Enterprises (FPEs)
    • which include companies registered under the Companies Act, sole proprietorships, partnership firms, HUFs and limited liability partnerships
  • Non-Profit Social Enterprises (NPOs)
    • which include Section 8 companies, trusts and societies.
• The key difference between these two categories is that they source different kinds of capital. Specifically, FPEs can raise equity while NPOs cannot

BENEFITS OF SOCIAL STOCK EXCHANGE:

• For social enterprises:
  • SSE platform will acknowledge the problems of investment fundraising for social enterprises
  • There is a great opportunity to unlock funds from donors, philanthropic foundations and CSR spenders, in the form of zero-coupon zero principal bonds.
  • Helps small social enterprises to gain trust among impact investors
• For investors:
  • SSE will bring greater transparency for social enterprises, assisting investors to better evaluate the social enterprises they would like to invest in
  • Investors in zero coupon zero principal bonds may also be awarded a tax benefit
• For social sector:
  • SSE is a significant step towards the encouragement of an ecosystem to support the growth of social finance because it:
  • Open up avenues for direct listing and streamlining funding mechanisms for NPOs
  • Innovation of new funding instruments and funding structures
• For government:
  • Government gets some relief on its welfare spending, as private sector enterprises could pool in capital for investing in social sector.
• For Indian society as a whole:
  • Improve our performances in human development indicators
  • Helps to improve India’s image on global front

CONCERNS:

• 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.
• Difficulty in social impact measurement
  • Absence of any universally applicable framework for social impact measurement
• Scope of participation:
  • 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
• Regulation of social impact assessment intermediaries:
  • SSE 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.
• 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.
• Chances of misuse of fund:
  • For-Profit Enterprises (FPEs) may invest the funds received through SSE, in a way that helps them to promote their main business.

WAY FORWARD:

• Key recommendations of technical group constituted by SEBI:
  • Eligible entities:
    • The group has said that both for-profit (FP) and not-for-profit organisations(NPO) should be allowed to tap the SSE.
  • Ineligible entities:
    • Corporate foundations, political and religious organisations should be made ineligible to raise funds using the SSE mechanism.
  • Eligible activities:
    • These include eradicating hunger, poverty malnutrition and inequality; promoting gender equality by empowerment of women and LGBTQIA+ communities; training to promote rural sports; and slum area development, affordable housing
    • These are based on those identified by NITI Aayog under sustainable development goals
  • Annual report:
    • Entities listed on SSE will have to disclose their social impact report on an annual basis.
    • This report should cover aspects such as “strategic intent and planning, approach, impact scorecard”.
  • Corpus size of the fund:
    • Minimum corpus size for such funds be reduced from Rs 20 crore to Rs 5 crore and the minimum subscription amount be reduced from Rs 1 crore to Rs. 2 lakh.
  • Modes available for fundraising:
    • For Non-Profit Social Enterprises (NPOs)
      • It shall be equity, zero coupon zero principal bond (ZCZP), development impact bonds, social impact fund, currently known as social venture fund (SVP) with 100 per cent grants-in grants out provision, and donations by investors through mutual funds.
    • For ‘For-Profit Enterprises (FPEs)’
      • It will be equity, debt, development impact bonds, and social venture funds.
• Clarity on definition of social enterprises:
  • Government will need to create a legal definition of a ‘social enterprise’.
• A common minimum standard of reporting social impact:
  • Measurement of social impact and the activity of social reporting must be institutionalized
• Building institutions:
  • SSE should also play a key role in ecosystem building, by encouraging institutions such as ‘social auditors’, which will perform independent verification of social impact reporting
• Capacity building fund:
  • SSE should set up a capacity-building fund to support to the smaller Non-Profit Social Enterprises (NPOs) to meet regulatory requirements
• Simplifying procedure:
  • Enable fast-tracking of getting certifications for Non-Profit Social Enterprises (NPOs)
• Tax benefits:
  • Allow philanthropic donors to claim 100% tax exemption for their donations under 80G of Income Tax
• Corporate Social Responsibility (CSR):
  • Allow funding to Non-Profit Social Enterprises (NPOs) on SSE to count towards CSR commitments of companies.
• Relax compliance and reporting standards:
  • The government should relax compliance and reporting standards to make the social stock exchange inclusive enough for all social entities to reap benefits.
• Facilitate overseas investors:
  • 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
  • This requires relaxation on the provisions of FCRA etc.

INTERNATIONAL EXPERIENCE:

• Kenya Social Investment Exchange:
  • The Kenya Social Investment Exchange, launched in 2011, connects vetted social enterprises with impact investors, both foreign and domestic.
  • A listed social enterprise has to demonstrate social impact as well as financial sustainability beyond the funding period.
• Social Stock Exchange in London:
  • The Social Stock Exchange in London functions more as a directory connecting social enterprises and potential investors.
  • Launched in 2013, it only accepts companies that pass its independent assessment on social impact.

CONCLUSION:

• The SSE is uniquely poised to become an important component of India’s policy response to Covid19.
• By expanding the pools of source capital and innovating new structures, SSE will substantially multiply the funding opportunities for the social sector.

PRACTICE QUESTION:

Q. “Social enterprises have the potential to make a significant impact on India's society and economy, but they struggle to find sustained funding”. In this context analyze the prospects and challenges of social stock exchanges?