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The Emergence of the Social Stock Exchange in India
This blog is authored by Shivani Pattnaik a second-year student at National Law University, Odisha.
Introduction
Social enterprises play a vital role in the advancement of society by enabling citizens to voluntarily work together to promote social values and social goals that are important to them. In a country like India, that houses over 3.1 million non-governmental organizations, funding these enterprises can be a herculean task. This is due to the fact that these sectors are widely unstructured, informal and usually function outside the confines of the market.
Though many forms of social enterprises exist, they can be primarily divided into For-Profit Social Enterprises (FPEs) and Non-Profit Organizations (NPOs). Also known as Section 8 companies, NPOs largely consist of non-governmental organizations, societies and trusts.
Since the objective of these enterprises is not profit, they rely heavily on philanthropic capital, governmental grants, corporate social responsibility donations, etc. However, over the past decade, India's domestic philanthropy has evolved significantly from non-profit to structured investments aimed at creating broader influence. India's impact on the investment space has also increased significantly. More than 550 Indian FPEs received approximately $10.8 billion in investment from 2010 to 2019. In 2019 alone, this figure was $2.7 billion. However, this type of funding is concentrated in already established social institutions.
Even when nascent non-governmental organizations (NGOs) get access to funding, sustaining the capital as well as the growth is challenging.
Recognising this complication, in the 2019-20 Union Budget, Finance Minister Nirmala Sitharaman proposed the idea to create a “social stock exchange.” It would be regulated by the Securities Exchange Board of India (SEBI). This initiative aims to aid public and voluntary organizations working for social purposes to raise capital in the form of equity, debt or unit of mutual funds. Moreover, it would display India's independence from foreign aid by providing a new and affordable source of funding for social welfare projects.
Building on the idea, SEBI formed a Working Group to develop a framework for coordinating non-profit organizations and companies, and to introduce requirements for financial performance and governance.
The Idea of Social Stock Exchange
In 2020, the SEBI Working Group presented a report delineating the format and content of the Social Stock Exchange.
In the report, the Working Group has described how to create social interactions that will become a fundraising opportunity and will include a set of procedures for measuring and reporting social performance of the NGOs. As per the report, one of the biggest hurdles for NGOs is visibility to investors and donors. Traditionally, to garner funds, NGOs need to show sustainable changes brought by them whereas to bring sustainable change, they require funds. It turns into a vicious cycle of lack of funds and as a result, lack of growth.
This is where the idea of the Social Stock Exchange comes to play. Similar to the existing stock exchange, it will act as a platform where social enterprises, voluntary groups and charities can be listed to raise capital from investors. For social enterprises, fundraising is a revolutionary concept aimed at achieving financial security goals. It would be a platform where people who want to contribute to public welfare meet with those who actually accomplish it (NPOs).
By utilizing the innovative tools, NPOs can use to communicate with the SSE (including direct listing through new kinds of securities) with proper disclosure of their objectives and funding requirements that provide investors and donors with a standard framework for measuring social impact.
Key recommendations
The Working Group made recommendations to make the idea of SSE viable in the Indian landscape.
Firstly, it elaborated on the issuance of bonds. Non-profit organizations can be listed directly by issuing bonds in the form of the zero-coupon bonds. These bonds are debt securities that do not pay interest but are traded at a large discount, providing a return to maturity when the bond is redeemed at nominal value. This facilitates CSR donors, charities, and sponsors contribute to the funding because it persuades them to purchase zero-coupon bonds.
The report also mentions exploring various funding avenues such as Social Venture Funds (SVFs). Not only will businesses be able to raise capital by SVFs, but they will also gain investor experience. Capitalists can lead these social enterprises so that they can reach their potential faster.
In addition, the social investment model provides a comfortable repayment model. Social Venture Funds also provide fast and adequate funding for social objectives. Socially responsible companies that make donations through CSR often focus on large projects which are time-consuming. Social venture capitalists understand this predicament and provide timely funding to launch smaller projects.
Furthermore, social stock exchanges can be listed on existing national stock exchanges such as the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). This allows SSE to leverage the already existing infrastructure and customer relationships to attract investors, donors and social capitalists. Some of the tax cuts allowed under the recommendations encourage participation in a culture of “donating” among various stakeholders. This will encourage banks and other investors to participate in non-profit institutions, making social and economic growth more inclusive.
Viability
As innovative and ideal as the idea of social stock exchanges may seem to be, the viability of the idea needs scrutinization. Among the many interesting takes, Dr R. Balasubramaniam’s research stands out the most. He has done a detailed report on the concerns and opportunities that emerge from a Social Stock Exchange. In his report, the Roadmap of Social Enterprise Ecosystem as a Precursor for a Viable Social Stock Exchange in India, he states that the SEBI report is a good starting point albeit to make SSE a fully functioning entity, a lot of work needs to be done.
He identifies the supply of funds as a primary concern. The existing stock exchanges around the world function to fulfil two core purposes i.e raising capital for business entities and providing returns on the shares to the shareholders. With social stock exchanges, on the other hand, there is a lack of incentive to the investors as the returns would be little to none.
The second issue at hand is regulation. The SEBI report focuses on how the SSE would function in the current market but doesn’t delve into the details of regulation. To be listed on existing stock exchanges, a business entity has to go through a number of checks to be listed. Prospectus, audit reports, future ventures of the entity are available for perusal to the general public. It invokes a sense of trust and generates an interest to invest in the shares in order to obtain favourable returns. However, there are concerns about how this process would apply to social enterprises.
It is difficult to quantify the profitability or social impact these enterprises generate. The parameters based on which a social enterprise can outperform the other, are unclear. Even if that is figured out, there is a glaring need to assess the enterprises’ work and long-term goals to have complete transparency in disclosing the enterprises’ information. Dr R. Balasubramaniam recommends defining and setting legal boundaries to a ‘social enterprise.’ He puts forth that the next place to start would be to measure social obligation in a way in which it becomes a monetizable commodity for an investor.
Conclusion
Any proposal to list a non-profit organization on the social stock market requires careful planning. To formulate these recommendations, India needs a comprehensive and rigorous approach to accreditation, evaluation and monitoring.
As the impact of Covid-19 on the global economy worsens, public and private sources of capital come together to ensure a smooth flow of capital to the social sector and develop innovative approaches to ensure the efficient use of capital to achieve lasting impacts. Organizational support through SSE allows more investors to support environmental aspects (e.g. resource conservation, sustainable practices), social aspects (including data protection, societal well-being) and personal aspects (e.g. diversity, inclusivity).
The idea is still at a nascent stage and many details have to be ironed out before it fully functions in India. To this end, every effort must be made to create a supportive regulatory environment for the proposed SSE with little burden on the government, social entrepreneurs and investors. For social enterprises using this platform, clear listing criteria should be established, and listing rules should provide investors with sufficient incentives to increase investment. Social performance evaluation and financial disclosure must be transparent to establish credibility.